Tag Archives: Risk

It has been announced that the LIBOR rate will undergo an overhaul. Some of the changes I picked up were:

It will be administered independently, not by the BBA (British Bankers Association)

The admistering body will fall under regulation of the FSA (Financial Services Authority); therefore, future rate fixing could result in jail sentences for the offenders

The rates will be audited, so banks will have to justify the rates put forward, based on actual transactions

The number of banks submitting rates will be increased

The number of currencies and interest rates involved will be drastically reduced so as to concentrate on the rates most used by investors and borrowers

The way in which the rate is determined, which had been thought may be changed will remain the same. It will be based on daily estimates by panels of banks, of the interbank borrowing rate. Although this method had been criticised earlier as not being objective, I guess the issue that was highlighted earlier is that in thin markets (e.g. in depressed economic conditions) too few or no trades take place, making it necessary to have an estimate.

This seems like a step in the right direction. I wonder if more reforms are to come to the banking industry. Many other questions are still worrisome. Are some banks too big to be properly managed? Do appropriate cultures of good governance exist within these organisations? Will the compensation structure be changed sufficiently to disincentivise ruthless risk taking? These concerns linger.

I attended an after-work drinks event recently, attended mostly by quants. It was intriguing for me to enter this world for a while.

I am not a quant, though, given my background (science, finance, risk, business) there is some chance I might have gone that route, given the right influence, had I stumbled upon this world when I was choosing career paths a long, long time ago. Nevertheless, I’m not one now but it’s always interesting to discover new worlds.

There was no doubt, this was a bunch that were passionate about what they do, launching every now and again into discussions about various models, the gammas, thetas, vegas and the rest of the greeks. Contrary to popular belief, I didn’t find this group nerdy or geeky – they engaged in lively chatter with the very few non-quants, and had a genuine interest in travel, hobbies, education, volunteer work, and making the world a better place.

What I perhaps did find a little disturbing was that dealing with risks, to this group, seemed mostly about problems with the models, and improving the models. The risk management problems were about technical problems – market risk, credit risk etc, so the models needed to be improved. Hang on, but what about all the other contributing factors, I thought – compensation design, miscommunication, groupthink, thinking short-term (shortsightedly) to keep shareholders happy and the more commonsense stuff? These must be for other people to deal with, I gathered.

We all (quants or otherwise) love our comfort zones – after all we are all uniquely wired up, aren’t we? I enjoyed the evening – the company and the drinks – but couldn’t help coming away thinking risk management is still happening in silos despite all the talk about it needing to be all-encompassing recent years.

It is good to hear that research is ongoing on the link between brain chemistry, biology and genes on risk taking behaviour (see “The American Banker”, 18 August 2012). I have often wondered why courses on risk management discuss models, complex mathematics, markets, operations etc. at length but stay silent on the topic of what, in an individual’s chemical make-up, triggers extreme risk-taking behaviour and how to address this. (Surely this has to be among the most obvious and directly related of factors.) Perhaps the science has not been sufficiently developed to be made useful in practice – we hope some time in the future it will be.

In “The Hour Between Dog and Wolf” – by John Coates, reference is made to the question asked, “why do bankers (traders) take such stupid risks?”, and the reply was along the following lines – “we get a thrill from risk….a hot streak releases a chemical high….this is where the Master of the Universe feeling sets in. It’s euphoria”. It is quite the opposite of euphoria for those who suffer the widespread consequences when things don’t go so well. One suggeston put forward there is for more ‘biological diversity’ among traders – something we hope the ongoing research will help ascertain the benefits of. As alluded to in the ‘American Banker’ article, appropriate compensation design is also critical, to curb extreme risk taking for short term results.

It’s a common (sloppy, I would say) expression that is used these days – I have even heard it used on newschannels such as CNBC. As a physicist, it was rammed hard into me, back in school, that the units are even more important than the numbers. “If I send you to buy eggs, I would rather you return with the wrong number of eggs than the right number of something else”, my physics teacher used to say.

It’s easy to think the meaning is obvious – “in this context it’s obvious it must mean two minutes”, you might say. It becomes habit. Imagine then, talking to someone far away, in another culture, not accustomed to this expression, where traffic jams and a laid back life are the norm – it will not be too difficult to see how the meaning could easily be mistaken to be two hours, two days or even two months!

Malcolm Gladwell, in his book “Outliers” talked about how lapses in communication (because of a lack of clarity and mitigation of the urgency of a message) have resulted in airplane disasters. Another airplane crash investigation I watched in National Geographic’s “Air Crash Investigation” series traced the cause of the crash to be confusion between the the metric and imperial systems of measurements.

We all think in terms of different units – and that’s fine, but why can’t we just be clear about what we mean? How much effort does it take to utter the two syllabus “mi-nutes” or the words for any other units for that matter? I wish we all would make it a good habit to state our units – we really don’t need a huge disaster to happen before we realise how easy it is to avoid some risks.

In life, we must take risks to move forward. “Dive into the depths of darkness in an elevator and fall to my death?” you might think, cynically. No, I mean we must take calculated risks and where possible we should engage in strategies to manage and mitigate these risks. Sometimes, of course, despite doing the calculations, we are taken by surprise and a catastrophe results – we then investigate, do post-mortems and hope the world will learn and do better next time.

If bold risks were never taken, we would not be enjoying fabulous air travel today. Yet, sometimes the risks taken end in catastrophic air crashes; some of these, we think, would have been avoided with better care and planning. There is a fine balance. This subject is very topical today, with corporate success and corporate failures, both bigger in scale than ever before, seen everywhere. This is my first post in this new blogging category I have created and I hope to add to this discussion in the future.